Thursday, November 29, 2012

Why doesn't the U.S. return to the gold standard so that the Fed can't "create money out of thin air"?

A.The phrase "create money out of thin air" refers to the Fed's ability to create money at virtually zero resource cost. It is frequently asserted that such an ability necessarily leads to "too much" price inflation. Under a gold standard, the temptation to overinflate is allegedly absent, that is, gold cannot be "created out of thin air." It would follow that a return to a gold standard would be the only way to guarantee price-level stability.

Unfortunately, a gold standard is not a guarantee of price stability. It is simply a promise made "out of thin air" to keep the supply of money anchored to the supply of gold. To consider how tenuous such a promise can be, consider the following example. On April 5, 1933, President Franklin D. Roosevelt ordered all gold coins and certificates of denominations in excess of $100 turned in for other money by May 1 at a set price of $20.67 per ounce. Two months later, a joint resolution of Congress abrogated the gold clauses in many public and private obligations that required the debtor to repay the creditor in gold dollars of the same weight and fineness as those borrowed. In 1934, the government price of gold was increased to $35 per ounce, effectively increasing the dollar value of gold on the Federal Reserve's balance sheet by almost 70 percent. This action allowed the Federal Reserve to increase the money supply by a corresponding amount and, subsequently, led to significant price inflation.

This historical example demonstrates that the gold standard is no guarantee of price stability. Moreover, the fact that price inflation in the U.S. has remained low and stable over the past 30 years demonstrates that the gold standard is not necessary for price stability. Price stability evidently depends less on whether money is "created out of thin air" and more on the credibility of the monetary authority to manage the economy's money supply in a responsible manner.

?? Leave it to a Ph.D. economist to help some, but confuse things even further. Forget price stability, I'd prefer some logical stability, some coherent discourse, and stably accelerating Adaptive Rate.

Roger, meant to add they still go offtrack by using the mythical words "unsustainable levels" Why don't these guys define what that unsustainable level is. I did ask them that followup question and am waiting to see their response in public before I post them here. It mentioned Zimbabwe!

this post just goes to show the MMT 'economists' on this blog dont understand austrian/anarcho-capitalist monetary theory or ABCT at all.

the point isnt that the government should be on a gold standard, although for the most part the gold standard has been better than the fiat standad. the point is that there shouldnt be any government monetary policy at all, gold standard or fiat standard, the market should determine this, government for the most part only screws things up, central planning has never been effective or efficient.

and as it is historically, the federal reserve and government has been far worse to prices and missallocation if resources and wealth through interest rate manipulation and intervention in the marketplace.

your post does little to prove your point, it mostly proves the point against your own arguement, that the government screwed up the monetary system and artificially manipulated the economy even further by raising prices, debasing the currency, and missallocating resources.

nice try though i guess. a better understanding of economic history as well as economic theory would have helped.

Thanks for your input, Daniel. Most of us have considered the alternatives from the point of view of a correct understanding of monetary operations. There are four ways that money is created, 1) using a real numeraire as a medium of account, e.g., bullion/specie, 2) state currency, 3) bank credit, 4) a combo of 2 & 3, which is what we have now, 5) digital money (experimental at present).

Most of the money used in transaction is bank credit. The GFC was not the result of state currency but bank credit being extended imprudently.

Some people would prefer to see a real numeraire used as the unit of exchange (deflationary), some only government currency (vests vast power in government), some bank credit (vests vast power in the financial sector) and some a combo of 2 & 3 (balances govt power and the power of the financial sector) but with reform that would reduce systemic risk and remove the criminogenic environment. Digital money is not yet a viable option nationally or globally although it is only in its infancy.

These alternatives all have advantages and disadvantages. Different people weigh those advantages and disadvantages differently for a variety of reasons.

Here we are looking at the present system and thinking how to improve it rather than replace it.

"These alternatives all have advantages and disadvantages. Different people weigh those advantages and disadvantages differently for a variety of reasons.

Here we are looking at the present system and thinking how to improve it rather than replace it."

i agree with the above, any austrian economist would. in a free market society different people would weigh the advantages and disadvantages of currencies and that is precisely why austrains maintain that currencies are best determined in the marketplace and not by a room full of government central planners determining the economic activity of 320million people interacting.

the historical evidence of this is largely on the side of the austrians and free market voluntary exchange economics than it is with government central planning and market intervention..